Across the eurozone, economic stagnation has become endemic, fiscal imbalances have become worse and the banking system is still suffering from the financial crisis of 2008. Here we look at the five big issues facing European policymakers.
Unemployment
Europe’s deepening problems are spelled out in impressive detail by the International Montary Fund (IMF) in its October 2014
World Economic Outlook report. Growth in output across the region in 2014 was 0.8% at best (after two years in negative territory) and 1.3% in 2015.
Even if this figure for 2015 is achieved, it will do virtually nothing to cure endemic unemployment, currently at 11.4% across the region. This total disguises wide variations within the eurozone, with unemployment at 4.8% in Germany and 4.9% in Austria, but 25.8% in Greece and 23.7% in Spain. There are also much higher levels of joblessness among the young.
Growth
Each of the three biggest economies in the eurozone is stagnating. Italy is going through a prolonged period of contraction, with output stumbling heavily in 2012, 2013 and 2014, and forecast to tumble again in 2015. Growth has ground to a halt in France, amounting to just 0.2% for the whole of last year.
Most seriously of all, Germany’s economy, which accounts for some 24% of the total output of the eurozone, is also stuttering, though it did redeem itself with a 0.7% growth spurt in the final quarter of 2014, which took its rate for the year to 1.6%.
Deflation
A major concern among global forecasters, such as the IMF, is that Europe stands on the edge of a deflationary spiral similar to that which occurred in Japan in the 1990s – and from which that country has never fully recovered.
Mighty Germany was the latest eurozone member to announce a decline in prices year-on-year at the end of January, an event that was blamed on the falling oil price. No fewer than 12 out of the 19 eurozone states are now suffering deflation, with prices falling 0.2% across the region as a whole in the year to December.
The deflationary scenario threatens a new era of uncertainty for investors in the bonds of eurozone countries. Deflation can lead to what economists call the ‘liquidity trap'. As the price of goods and assets fall, holding cash and other short-term monetary assets becomes ever more value-accretive. The best investment could be a home safe stuffed with cash.
Take an interest
Want to join the CISI European Regulation Interest Group?
To sign up, email pfs@cisi.orgBonds will tend to rise in value during periods of deflation, as when a bond matures the money paid back could be worth considerably more than what the issuer raised by selling the bond in the first place.
Sovereign bonds, backed by governments, should remain safe. However, if there were to be an extended eurozone crisis, and the future of the single currency were called into question, then all bets would be off.
Quantitative easing (QE)
One of the lessons of the Great Recession is that governments that were willing to put to one side anger at the role of the banks and financiers in the creation of the crisis, and move to bail them out and recapitalise them, are those currently showing most progress. The Bank of England and the US Federal Reserve led the way in providing emergency assistance to their banking systems following the financial crash of 2008 and, as a result, growth in the US for 2015 is forecast at 2.3% and in Britain at 2.7%. Among the eurozone nations, Spain and Ireland followed suit, and both countries are showing some signs of emerging from the danger zone.
The European Central Bank did not introduce its own QE programme until January 2014. Then, prompted by the news that the eurozone had fallen into deflation for the first time in December, Mario Draghi – the Italian President of the ECB – announced an 18-month 1.1tn euro bond-buying spree in a bid to raise inflation to something approaching its 2% target.
The idea is that by making banks more liquid, interest rates will fall, and people will be more inclined to borrow for investment and job creation, thus stimulating the economy.
Grexit
The prospect of Greece giving up the euro has never been more real following the victory of anti-austerity party Syriza in January’s general election. While such a move would have drastic consequences for Athens, it would have less impact elsewhere in the eurozone, and certainly need not spell the end of the euro.
The original version of this article was published in the December 2014 print edition of the Review.